Understanding quantitative easing – and what it means for you


The Covid19 pandemic has triggered the sharpest economic contraction on record earlier this year as nationwide restrictions were brought in to try to contain the virus.

Now, the Bank of England has promised to do whatever is required to get Britain’s economy back on its feet – including printing more money.

In a process known as quantitative easing, it will create an extra £150 billion and pump it into the economy.

At Continuum we are looking at just what this means for the UK, and what it means for your own finances.

What does quantitative easing mean?

Talk of printing money suggests images of the Bank of England print works in Essex running night and day. Sadly, it is only a metaphor. The bank is going to create new money electronically, and spend most of it buying government bonds through the process known as quantitative easing (QE).

QE is often described as “printing money” by headline writers, but in fact no new physical bank notes are created.

The aim of QE is simple. By creating ‘new’ money, the bank aims to boost spending and investment, with the intention of reviving an economy that is depressed by the effects of Covid and by fears about Brexit.

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Why is it necessary?

In normal times, the bank will use the base lending rate to control the economy. If the country’s finances are looking unsustainable, it can put the rate up, to discourage some spending, lending and borrowing to calm things down.

When things go wrong, and there is a lack of confidence and of willingness to invest the bank can drop interest rates, making borrowing cheaper, and stimulating the economy.

When the global recession hit in 2008, the bank lowered Base Lending Rate from 5% to 0.5% to support the UK’s economic recovery. Lower interest rates mean it’s cheaper for households and businesses to borrow, which encourages them to spend and invest, whether that’s someone buying a new car or a company buying a new factory to build cars.

The problem is that with the Bank of England base rate now just 0.1%, there is no scope for dropping any further. It might be possible to make rates negative – meaning that savers will pay the bank for the privilege of having money on deposit, but this unlikely to be popular, and very likely to cause further disruption.

Quantitative easing is the bank’s second line of defence for the economy, a way of stimulating spending and investment without the rate becoming negative.

How it works

Quantitative easing can have a similar effect to lowering interest rates, although it will be indirect.

Making large scale purchases of government bonds pushes the price up: when demand for anything increases, the price usually goes up too. But with bonds, the returns are fixed, which means that the interest rates or ‘yields’ on those bonds are effectively reduced. Investors need to pay more for the same return.

Rates on government bonds tend to affect other interest rates in the economy. This pushes down the interest rates offered on loans such as mortgages or business loans.

So, QE works by making it cheaper for households and businesses to borrow money – encouraging spending.

But the effect does not stop there. QE can stimulate the economy by spreading the extra wealth around.

So for example, if the bank buys £1 million worth of government bonds from a pension fund, the pension fund now has £1 million in cash. It will not want to keep this money as cash, and will reinvest it in financial assets, such as shares.

This will increase demand for financial assets which in turn means that the value of these assets increases. This makes businesses and households holding shares wealthier – making them more likely to spend more, boosting economic activity.

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What does this mean for your money?

Quantitative easing could be good news for the economy, and for you personally if you hold shares or other investments which could appreciate in price as a direct result.

Of course, as always there is a downside. There is a risk that inflation could be triggered, making cash savings even less attractive as their value is eaten up by inflation.

It might be time to look at your financial plans and particularly your investment portfolio to ensure that QE will have a positive effect, rather than leave you worse off.

This could be complicated, and the best way to approach it is with an expert at your side. At Continuum, we are ready to provide all the expertise you need. Simply call us to arrange an appointment and see if QE could mean printing money for you.

 

The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to a suitable investment strategy, you should seek independent financial advice before embarking on any course of action.

The value of investments can fall as well as rise and you may get back less than you invested. Equity investments do not afford the same capital security as deposit accounts.

The Financial Conduct Authority does not regulate finance

https://www.bankofengland.co.uk/monetary-policy/quantitative-easing

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